Hugging Russian Bear May Lead to a Mauling from EU

Adam Smith never met Vladimir Putin, but, as with so many other things, he anticipated his appearance. Nobody can accuse the great Scot of protectionist proclivities, but he did warn that there are times when free trade takes second place to national defence. He proposed laying "some burden" on foreign commerce "when some particular sort of industry is necessary for the defence of the country ... (since) defence is of much more importance than opulence".

America, Britain and other free-trading countries have long welcomed foreign investment on the ground that it enriches the nation by bringing capital, jobs and foreign know-how to the country. In America, approval by the government of the acquisition of port facilities by an Arab country prompted a review of procedures so secretive and arcane that the president found out about the deal only when it leaked to the newspapers.

Naturally, the deal-making community fought to prevent any tightening of the rules, because City folk agree with Adam Smith only when he argues for limiting government powers, and not when he wisely suggests that defence takes precedence over opulence -which today means homeland security over bonuses for investment bankers.

Now the western democracies have to decide what to do about acquisition-minded Russian companies, flush with cash, and ordered by Putin to extend their global reach. America's committee on foreign investment last week agreed to let the Russian steel company Evraz acquire Oregon Steel Mills for $2.3 billion (£ 1.2billion). Its members found nothing troubling in the deal, even though Oregon Steel is an important supplier of armour plate to the American military, and Evraz's main investor is Roman Abramovich. Alone among the oligarchs, Abramovich retains the favour of Putin. He is the man the Russian president appointed governor of Chukotka, in remotest Siberia, so that Abramovich could prove his loyalty by bankrolling its economic development -which he has faithfully done.

One might say that while relations between Putin and other expatriate Russians have been poisoned, those between the Evraz owner and Putin have not. Which suggests that when Russia decides to have Oregon Steel fall behind in deliveries of armour plate to the American military, Oregon's management might decide, perhaps over dishes of sushi, that profit maximisation is not the only consideration.

But this is trivial compared with the dilemma faced by Britain and the EU. Putin regards his nation's oil and gas reserves as a political weapon. When challenged, he has cut off gas supplies to Ukraine and Georgia, and stopped the flow of oil through the pipeline crossing Belarus, forcing refineries in Poland, Germany, Slovakia, Hungary and the Czech Republic to dip into reserves to keep operating.

Only after Belarus's president agreed to eliminate all transit charges and, more important, cede control of Belarus's pipeline, would Putin allow the president of Russia's monopoly pipeline, Transneft, to open negotiations over future prices and fees. The German chancellor, Angela Merkel, called the supply cut-off "unacceptable", which will not worry Putin unless Europe unites to solve its dependence problem -not a likely prospect.This follows on the heels of Putin's sudden discovery that Shell's operations in the Sakhalin gasfield were breaking environmental regulations. Given the choice of abandoning their investment entirely, or selling to state-owned Gazprom, Shell and its Japanese partners chose the lesser of the evils.

Of course, none of this would have happened had European leaders heeded the warnings of Ronald Reagan. In the 1980s he decided that European reliance on Russian energy supplies would inhibit it from siding with America in any showdowns, and attempted to prevent the sale of equipment to the pipeline's builders.

Not for the first or last time, Europe ignored American warnings. Now EU free-traders who believe in the efficiency-enhancing effects of the free flow of capital see their theoretical belief foundering on the rock of their energy dependence. Russia has billions available to invest in overseas companies. It refuses to allow foreign investment in its own renationalised energy infrastructure, but insists on its right to buy up the energy infrastructure of other countries. Result: the Russians have pipeline monopolies into Europe, and want to extend the reach of those monopolies beyond Russia's borders, deep into the heart of Europe.

Gazprom is believed to be planning to make a bid for Centrica, the British gas distributor that also supplies gas and electricity to 1.5m customers in nine American states. It will then move on to attempt takeovers of key energy infrastructure projects in America.

So America, Britain, Germany and other countries with histories of supporting free trade now have to make the choice with which Adam Smith confronted policymakers more than 230 years ago -defence or opulence; preventing hostile nations from gaining control over key resources, or adding a bit to national wealth by attracting more inbound investment.

One Gazprom spokesman defends any such acquisition as extending consumer choice.The dealmakers, eager to make 2007 bonuses a repeat of 2006, will throw their weight behind approval. But they won't be able to cite Adam Smith in support of opulence over defence. Which will be a comfort to Gordon Brown when the time comes to choose.